The Biden administration and its allies in Congress are now considering a “billionaires’ tax” on the unrealized capital gains of billionaires’ stock holdings. Nothing is so well designed to collapse the whole house of asset-bubble cards, as the billionaires re-direct their investment towards areas that are not caught by this impost. It therefore seems worthwhile for us mere mortals to devote some thought to the concept of “investing without assets,” putting your money in areas that will be proof against the asset bubble’s collapse, mostly because they have not shared in the asset bubble’s hyper-inflation.
As always with new legislation, the details of the Biden tax are ill-defined. One version has tax on investments in private equity, art and real estate deferred until the asset is sold – thus in those areas, no difference whatever from what we have now. A scheme along those lines would raise very little revenue and while interest rates are ultra-low and money is so easy, would drive every company on Wall Street to privatize itself to one of the big private equity firms, thereby saving oodles of tax for its richest shareholders.
That would undoubtedly collapse the asset bubble, because even today’s overcapitalized private equity industry could not handle the entire S&P 500 privatizing at once. It would also leave only the companies least attractive to billionaires quoted on the exchanges. Those companies might then be very good investments, but the change would make capitalism entirely an insider game for billionaires, which is surely not a Biden objective. All round, a tax that exempted private equity, art and real estate would be very unattractive, yielding almost no revenue and locking out ordinary investors even further from the capital markets.
Let us assume therefore that the Biden tax is rational, and treats private companies, art and real estate in the same way as public company investments. For public companies, it would not then be a major problem; their billionaire holders could simply sell a few shares each year to pay the tax. Thirty years ago, it would not have been a problem for private companies or art, either, because there was no way of valuing such investments; the IRS cannot come and collect extra cabbage from you if it cannot prove your holdings have increased in value. Even then, real estate would have posed a problem for its investors: there was an active market in office, industrial and retail real estate, as well as residential real estate so values could be calculated.
Today, alas, private equity and art investments both have active valuation systems, writing up values year by year, so that fund investors can be paid their “carried interest” on the write-up. If values are being calculated and “carry” payments made on their basis, the IRS can impose taxes based on them. A system that imposed taxes on unrealized gains in private equity, art and real estate would thus be perfectly workable. The less liquid and more indebted billionaires would have trouble coming up with the money to pay the tax, but that would be their problem, not the government’s.
There is a much better way for the government to get more money off billionaires, and that is to abolish the charitable tax deduction, or cap it at a low level such as $10,000 per taxpayer per annum. “Charitable” donations are the principal means by which the ultra-rich avoid paying tax, instead devoting their money to leftist agitation, wokery and Versailles-like social engagements, thereby gaining brownie points with their much younger trophy wives.
Shutting down this gigantic scam would benefit the U.S. economy in two directions at once: greatly increasing its tax capacity and, more important, cutting wokery and fraud such as Mark Zuckerberg’s disgraceful $400 million interference in the mechanisms of the 2020 election. Naturally this will never happen, particularly with a Democrat administration.
So how should billionaires and, more important, the rest of us invest with this new system in place? No question about it, the change will crash asset prices. With holding shares and other instruments with high and appreciating asset prices so expensive, billionaire will have to find an alternative way will to invest. Since the billionaires’ simultaneous exit from asset-appreciating investments will crash their prices, the rest of us should also avoid this overpriced rubbish. The existential question therefore comes down to: how do you build your wealth and income without investing in appreciating asset prices?
Ask the question, and the answer begins to appear. In the last economic cycle resembling this one, that of the early 1970s, a minor British scandal involved prime minister Harold Wilson’s secretary Marcia Williams and her brother using their connections to invest very profitably in 1974 in some slag heaps in Lancashire. At that time, slag heaps, the gigantic piles of waste resulting from coal mining, were known only as having caused the dreadful Aberfan tragedy of 1966, in which a slag heap subjected to heavy rain engulfed a local school, killing many of the pupils. Nevertheless Ms. Williams, the future Lady Falkender, a very shrewd cookie if ever there was one, found a way to make a huge profit (by the standards of the day) out of slag heaps, at a time when all other investments were plummeting in value.
The secret to making profits without showing asset appreciation is to have investments that generate cash flow without asset appreciation. One such investment, much appreciated by the punters of the 1690s, was the tontine. In a tontine, you put in money up-front, then receive an annual return for as long as you live, just like an ordinary annuity. However, the tontine’s special feature is that the total amount paid to all holders remains the same as people die, so that by living for a very long time your annual payment goes up and up. If you live longer than all other holders, you enjoy the entire annual payment. Tontines were a very expensive way to finance the government in the 1690s, because nobody could value them properly; that now becomes an attractive feature as you can enjoy annual payments while only paying tax on a fraction of your annual receipt (because part of it is deemed to be a return of capital) while nobody can tax you on the appreciation, because nobody can calculate what your investment is worth.
Another even better class of investment, especially for billionaires, is those that are low-priced and unfashionable because they have a huge long-term environmental cost attached, possibly slag heaps but also coal mines, for example. Coal mines with an assured market give off a healthy if variable cash flow, yet climate-conscious bureaucrats are always trying to close them down. Hence their value is far less than the value of the cash flows they generate, because you must discount for the chance that regulatory change will close them and subtract the costs of cleaning up after their closure. With a good accountant, not only will their value not increase it will decline year by year, thereby offsetting the increase in value of your other investments, while the coal mines’ cash flow will come in useful paying tax bills.
Nuclear plants, if you are rich enough, offer another such investment. They are very reliable, throwing off cash flow year after year, yet the post-operational cleanup cost is unknown, and with an appropriately creative accountant can be inflated to almost any value. A mix of coal mines and nuclear plants will throw off unknown future liabilities that can offset almost any amount of capital gains – they are thus the ideal tax shelter in this new world. For billionaires, they are ideal investments. For the rest of us, they also have attractions, in not being overvalued by the wokies of ESG (environmental social and governance) investment. With that movement having had plenty of time to place its bets and force up prices, investing against it should provide generally superior returns.
In general, a principle can be stated: in the world of deflating asset values, reliable (but not necessarily predictable) cash flow is the principal requirement for membership in one’s investment portfolio. Predictable cash flows, such as bond interest, can be valued using a discounted cash flow methodology, which will cause their asset values to be overstated in periods when interest rates are artificially low. Unpredictable cash flows cannot be valued and discounted at low rates, hence are more valuable. Cyclical stocks on low P/E ratios, which pay out a high percentage of earnings as cash dividends, are therefore the investments to look for.
For the few readers of this column that are billionaires, you have financial advisors aplenty, and I would not venture to compete with them. I would simply suggest that unquantifiable future liabilities, notably through global warming or environmental cleanup, may be the best tax shelters you can find if the Biden tax plan is implemented. With careful management, you can achieve positive annual cash flow and an increasingly negative reported value, surely the tax management nirvana!
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)